Introduction

US Inflation Over the Decades

Inflation, a general increase in prices and fall in the purchasing value of money, is a complex and multifaceted economic phenomenon. It impacts every segment of society, from consumers and businesses to policymakers and investors. This exploration focuses on the fluctuations and patterns of US inflation over the decades, tracing its roots, its implications, and its broader economic significance.

Economic Impacts and Broader Repercussions

Inflation doesn’t just influence prices at the supermarket or the gas station. It’s a key indicator of economic health and carries implications for monetary policy, interest rates, and overall economic stability. High or hyperinflation can erode savings, distort spending behavior, and create uncertainty, while deflation can signal a contracting economy and lead to decreased consumer spending. Understanding inflation’s trajectory is crucial for predicting its future implications and formulating responsive strategies.

U.S. Inflation History and Key Monetary Changes

1. Early U.S. History (1776-1914): U.S. inflation was largely influenced by wartime periods. The Gold Standard was in place, tying the dollar’s value to gold. Wars like the Civil War and WWI led to temporary abandonments of this standard, resulting in inflationary spikes, notably a 20% rise in 1918. However, post-war periods and a return to the Gold Standard often brought about deflation and stabilization of prices.

2. Transition to Bretton Woods (1930s-1944): The Great Depression saw deflationary trends due to the monetary system’s rigidity. By 1933, the U.S. completely left the Gold Standard. In 1944, the Bretton Woods Agreement established the dollar as the main global reserve currency, pegged to gold.

3. 1970’s Changes: Concerns arose in the 1970s about gold’s ability to cover the increasing U.S. dollar supply. Factors like military expenses caused money supply surpluses. In 1971, President Nixon abandoned Bretton Woods, introducing a floating exchange rate system. Subsequent oil shocks in the 1970s resulted in inflation rates exceeding 12% and later 13%.

4. Volcker’s Approach (1979 Onwards): Paul Volcker, Federal Reserve Chair, implemented a new strategy in 1979. Instead of controlling inflation via interest rates, the focus shifted to controlling the money supply. This led to high interest rates, reaching 20% in 1980. However, by 1983, inflation fell below 4%, and the measures introduced during the Volcker era have helped maintain relatively stable inflation levels over the subsequent decades.

U.S. Inflation: Today

As the U.S. economy reopens, consumer demand has strengthened.

Meanwhile, supply bottlenecks, from semiconductor chips to lumber, are causing strains on automotive and tech industries. While this points towards increasing inflation, some suggest that it may be temporary, as prices were depressed in 2020.

At the same time, the Federal Reserve is following an “average inflation targeting” regime, which means that if a previous inflation shortfall occurred in the previous year, it would allow for higher inflationary periods to make up for them. As the last decade has been characterized by low inflation and low interest rates, any prolonged period of inflation will likely have pronounced effects on investors and financial markets.

Recently, national attention has shifted to the increases in inflation which has been attributed to a number of factors such as the war in Ukraine, supply chain disruptions, and monetary spending. Many of these factors were a result of the COVID-19 pandemic and subsequent government stimulus packages.

Economist point to three main drivers of inflation, the first of which is demand-pull inflation where it is theorized that excess consumer demand leads to companies raising their prices and thus increasing inflation. Next is cost-push inflation which says that when the cost for raw and intermediate goods increases then that pushes companies to raise their prices and pass the cost onto consumers. Finally, monetary policy affects inflation where increases in the money supply reduce the value of the dollar meaning consumers can buy less with the same amount of money, effectively increasing prices and inflation.

Literature Review:

Inflation has been a major subject of economic discourse for decades.Numerous studies have also debated the cause-and-effect relationship between inflation and employment, often referencing the Phillips Curve. However, as economies evolve and face new challenges, from technological advancements to global pandemics, the determinants and repercussions of inflation become ever more complex.

The literature has broadly evolved from macroeconomic theories of the past to more nuanced, data-driven analyses today. Yet, despite extensive research, predicting inflation remains a complex endeavor due to its multifaceted nature and global interdependencies.

1. Historical Monetary Perspectives: Beyond Friedman and Schwartz’s seminal assertion that inflation is fundamentally a monetary phenomenon, earlier works by Irving Fisher (1911) in “The Purchasing Power of Money” presented the Quantity Theory of Money, postulating a direct relationship between the money supply and the overall price level.

2. Structuralist vs. Monetarist Views: The 1970s saw a divergence between structuralists and monetarists. While monetarists, led by figures like Milton Friedman, insisted on the primacy of money supply, structuralists argued for the role of other factors, like wage and price rigidities. The Latin American hyperinflations of the 1980s further intensified this debate, with authors such as Dornbusch and Edwards (1990) exploring the structural and external debt drivers of such inflationary episodes.

3. Globalization and Inflation: As economies became more intertwined, researchers like Rogoff (2003) began to examine how globalization impacts inflation. They found that increased trade and financial openness often put downward pressure on prices, given the competitive forces at play.

4. Behavioral Economics & Inflation Expectations: Akerlof, Dickens, and Perry (1996) introduced behavioral elements, suggesting that people’s inflation expectations could be sticky due to cognitive biases. Their work underscores that beyond raw economic factors, human psychology plays a crucial role in inflation dynamics.

5. The Role of Central Banks: Blinder (1998) has stressed the pivotal role of central banks in managing inflation expectations, advocating for transparency and credibility in monetary policy. This idea was further echoed by Taylor (1993) with the introduction of the Taylor rule, emphasizing the importance of systematic monetary policy in response to inflation and output fluctuations.

6. Inflation in a Post-Crisis World: Post the 2008 financial crisis, discussions around inflation took a new turn. Authors like Ball and Mazumder (2011) explored the flattened Phillips Curve, observing weaker links between unemployment and inflation. In more recent times, with economic downturns triggered by global events like the COVID-19 pandemic, scholars have started probing the disinflationary effects of such demand shocks and their potential transition to longer-term inflationary pressures due to fiscal stimuli and supply chain disruptions.

In sum, while historical perspectives on inflation laid the groundwork for our understanding, ongoing research continues to highlight its multifaceted determinants, influenced by both domestic policy decisions and global economic dynamics.

Analytical Angles:

1. Historical Context:

   a. Objective: To discern the trajectory of inflation within the U.S., pinpointing significant periods of hyperinflation or deflation, and identifying the underlying causes for these shifts.

   b. Key Considerations:

   • Periods of rapid inflation post-World Wars, the Great Depression’s deflationary effects, the stagflation of the 1970s, and more recent trends post the 2008 financial crisis.

   • Historical events, such as the abandonment of the Gold Standard and the Bretton Woods system, and their ramifications.

2. Policy and Inflation:

   a. Objective: To understand the role of the government, especially the Federal Reserve, in shaping the inflationary landscape through monetary and fiscal policies.

   b. Key Considerations:

   • The influence of interest rates, money supply, quantitative easing, and fiscal stimuli on inflation rates.

   • The effectiveness and unintended consequences of policies like Paul Volcker’s efforts in the 1980s or the unconventional monetary policies post the 2008 crisis.

3. Global Events and Inflation:

   a. Objective: To gauge how exogenous shocks, be they geopolitical or economic, have impacted the U.S. inflationary environment.

   b. Key Considerations:

   • The 1973 and 1979 oil crises and their inflationary aftereffects.

   • The impact of global recessions and recoveries, such as the dot-com bubble burst or the 2008 financial meltdown. Geopolitical events like wars or trade tensions and their implications on the U.S. inflation rate.

Each of these angles offers a distinct vantage point, together ensuring a comprehensive exploration of the multifaceted nature of U.S. inflation.

The Big Picture:

Guiding Questions:

1. How has the pattern of inflation rates in the United States evolved over the last 50 years?
2. What economic sectors have been most affected by inflationary changes in the United States over the last 50 years?
3. What is the relationship between inflation and key economic indicators such as unemployment, wage growth, and GDP over the past five decades?
4. Can univariate time-series models (like ARIMA/SARIMA) effectively predict future inflation rates in the United States based on past data from 1970-2023?
5. Can multivariate time series models, including ARIMAX and VAR, improve predictions of yearly inflation rates in the United States by including variables like Federal Reserve interest rate decisions, GDP growth, and unemployment rates?
6. What is the correlation over time between inflation rates and key economic indicators like unemployment or GDP growth in the United States? How well do VAR models capture this relationship?
7. How do predictions of yearly inflation rates from a comprehensive ARIMAX model compare with those from simpler time series models and advanced methods like Deep Learning?
8. Using volatility models like ARCH/GARCH, to what extent can financial market indicators provide insights into inflation trends in the United States?
9. Can Deep Learning models, particularly Deep Recurrent Neural Networks, effectively capture the underlying patterns of monthly inflation rates from 1970-2023? Which models perform best and why?
10. How far into the future can Deep Learning models, specifically Recurrent Neural Networks, accurately forecast monthly inflation rates? Which models are most effective and why?